lecture 1 fsa

8/3/2019 Lecture 1 FSA

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1

Business Analysis Using

Financial StatementsLecture one

Suborna BaruaUnited International University


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Learning Objectives

1. Explain business analysis and its relation

to financial statement analysis

2. Identify and discuss different types ofbusiness analysis

3. Describe the component analysis

4. Learn the sources of financial information5. Accounting system features

6. Company reporting strategy


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3

Introduction to Business Analysis

Evaluation Prospects Evaluation Risk

Business Decision Makers

Equity InvestorsCreditors

Managers

Merger and Acquisition Analysis

External Auditors

Directors

Regulators

Employees and Unions

Business analysis is the evaluation of a companys prospects

& risks for the purpose of making business decision


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Introduction to financial statement analysis

Financial statement analysis is the process of

analyzing financial information to predict the

future financial performance and condition

An important part of business analysis

Provide a systematic and effective statement

analysis

Reliable inferences are drawn about a companyprospects and risks


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Types of

Business

Analysis

Credit Analysis Equity Analysis

Management &

Control

Mergers, Acquisitions

& Divestitures

Director OversightRegulation

External Auditing

Labor Negotiations

FinancialManagement


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Credit Analysis

LiquidityAbility to meet short-

term obligations

Focus:

Current Financialconditions

Current cash flows

Liquidity of assets

SolvencyAbility to meet long-

term obligations

Focus:

Long-term financialconditions

Long-term cash flows

Extended profitability

Credit worthiness: Ability to honor credit obligations(downside risk)


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Equity Analysis

Passive Investing

(beta strategies)

Aim:

Diversification

based on risk

propensity &

investment horizon

Example: Indexing

Active Investing(alpha strategies)

Aim:

Beat the market --earn above normalstock returns

Examples: Technical

analysis & Fundamental

analysis


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Intrinsic Value

(or Fundamental Value)

Intrinsic value > Market value Buy

Intrinsic value < Market value SellIntrinsic value = Market value Hold

Value of Company (or stock) without

reference to market value (or stock price)

Strat

egy


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Management and Control

jManagers are hired by a companys owners

to manage its business activities

jManagers make operating and financingdecision based on business analysis

jManagers monitor and control company

activities through the process of business

analysis


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Accounting Analysis

Comparability problems across firms and across time

Manager estimation error

Distortion problems Earnings management

Distortion of business

Accounting

Risk

Process to evaluate and adjust financial

statements to better reflect economic reality


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Strategy Analysis

The purpose of Business Strategy Analysis

Identify key profit drives and business risks

Assess companys profit potential at aqualitative level

Strategy Analysis involves

Industry analysis

Competitive strategy

Corporate strategy analysis


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Industry Analysis

Analyzing a firms profit potential must first assessindustry profitability. It includes:

Degree of actual and potential competition

(1) Rivalry among existing firms(2) Threat of new entrants

(3) Threat of substitute products

Bargaining power in input and output markets

(1) Bargaining power of buyers

(2) Bargaining power of suppliers


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Competitive strategy analysis

Competitive strategy analysis is the evaluation of a

companys decisions and success at establishing a

competitive advantages

Cost leadership: supply same product and serviceat the lower cost

Differentiation: supply a unique product or service

at a cost lower than the price premium customerswill pay


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Corporate strategy analysis

Involves examining whether a company is

able to create value in multiple businesses

A well-crafted corporate strategy reducescosts or increase revenues from running

several businesses in one firm.

Cost saving or revenue increases come from

specialized resources that the firm has to

exploit synergies across these businesses


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Prospective

AnalysisAccounting

Analysis

Business

Environment &Strategy Analysis

Industry

Analysis

Strategy

Analysis

Financial

Analysis

Analysisof Sources

&Uses of

FundsProfitability

Analysis

Risk

Analysis

Cost of Capital Estimate Intrinsic Value


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Financial Analysis

Profitability analysisEvaluate returnon investments

Risk analysis Evaluate riskiness

& creditworthiness

Sources and uses Evaluate source &

of funds analysis deployment of funds

Common tools

Ratioanalysis

Cashflow

analysis

Process to evaluate financial position and

performance using financial statements


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Prospective Analysis

Intrinsic Value

Business Environment

& Strategy Analysis

Accounting Analysis

Financial Analysis

Process to forecast future payoffs


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Sources of financial information

j Principle financial statements

The balance sheet

The income statement

The statement of cash flow

The statement of stockholders equity

Notes to the financial statements

Auditors report Management discussion and analysis

Other data sources

Chairpersons letter, Finance press, Web sites,

Industry statistics, Economic indicators.


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KodakDec 31, 1998 (In millions, except per share data)

Liabilities andAssets Shareholders EquityCurrent Assets

Current LiabilitiesCash and cash equivalents $ 457Payables $ 3,906

Marketable securities 43Short-term borrowings 1,518

Receivables 2,527Taxes - income and other 593

Inventories 1,424Dividends payable 142

Deferred income tax charges 855Deferred income tax credits 19

Other 293Total current liabilities 6,178Total current assets 5,599

OtherLiabilitiesProperties

Long-term borrowings 504Land, buildings and equipment at cost 13,482Post-employment liabilities 2,962

Less: Accumulated depreciation 7,568Other long-term liabilities 1,032

Net properties 5,914Deferred income tax credits 69

Other AssetsTotal liabilities 10,745Goodwill (net of accumulated

amortization of $534) 1,232 Shareholders' EquityLong-term receivables andother non-current assets 1,705 Common stock, par value $2.50 per share,

Deferred income tax charges 950,000,000 shares authorized; issued

Total Assets391,292,760 shares

Additional paid in capital

978

Retained earnings

902

Accumulated other comprehensive loss

6,163

(111)

Treasury stock, as cost, 68,494,402 shares

7,932

Total shareholders' equity

3,944

Total liabilities and equity

3,988

$ 14,733

283

$ 14,733


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Balance Sheet

Total Investing = Total Financing

= Creditor Financing + Owner Financing

Kodak Financing

$14,733 = $10,745 + $3,988


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Income StatementKodak

For Year Ended Dec. 31, 1998 (In millions, except per share data)

Sales $13,406Cost of goodssold 7,293

Gross profit 6,113Selling, generaland administrativeexpenses 3,303Research and development costs 880

Purchased research and development 42Restructuring costsand asset impairments -

EARNINGS FROM OPERATIONS 1,888

Interestexpense 110

Other income (charges) 328Earnings before incometaxes 2,106

Provision for incometaxes 716Earnings from continuing operations 1,390Gain on sale of discontinued operations -

NET EARNINGS $

1,390


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Statement of Shareholders EquityKodak

For year ended Dec. 31, 1998

Accumulated

Additional Other

Common Pail In Retained Comprehensive Treasury

(In millions, except number ofshares) Stock Capital Earnings Income (Loss) Stock Total

Shareholders Equity Dec 31, 1997 978 914 5,343 (202) (3,872) 3,161

Netearnings - - 1,390 - - 1,390

Other comprehensive income (loss):Unrealized holding gainsarising during

period ($122 million pre-tax) - - - - - 80

Reclassification adjustment for gains includedin netearnings ($66 million pre-tax) - - - - - (44)

Currency translation adjustment - - - - - 59

Minimum pension liability adjustment($7 million pre-tax) - - - - - (4)

Other comprehensive income - - - 91 - 91

Comprehensive income - - - - - 1,481

Cash dividends declared - - (570) - - (570)

Treasury stock repurchased (3,541,295 shares) - - - - (258) (258)

Treasury stock issued underemployee plans

(3,272,713 shares) - (58) - - 186 128

Tax reductions- employee plans - 46 - - - 46

Shareholders Equity Dec 31, 1998 $978 $902 $6,163 ($111) ($3,944) $3,988


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Statement of Cash Flows

Cash flows from operating activities:

Earnings from continuing operations $ 1,390Adjustmentsto reconcileto net cash provided by operating activities:Depreciation and amortizationPurchased research and developmentProvisions (benefit) for deferred incometaxes(Gain)loss on sale/retirement ofassets(Increase) decrease in receivables (1)(Increase) decrease in inventories(Decrease) increase in liabilitiesexcluding borrowings (516)Other items, net (278)

Totaladjustments 931,483

Cash flow from Investing activities:Additionsto properties

(1,108)Proceeds from sale ofassetsCash flows related to sales of businesses (59)

Acquisitions, net of cash acquired (949)Marketablesecurities- sales 162Marketablesecurities- purchases (182)

Net cash used in investing activities (1,839)Cash flows from financing activities:Net increase (decrease) in borrowings with original maturities of 90 days orless 894Proceeds from other borrowings 1,133Repayment of other borrowings (1,251)

Dividendsto shareholders (569)Exercise ofemployeestock options 128Stock repurchase programs (258)Net cash provided by (used in) financing activities 77

Effect ofexchange rate changes on cash 8

Net (decrease) increase in cash and cash equivalents (271)

KodakFor year Ended Dec. 31, 1998 (In millions)

Net cash provided by operating activities

(166)

42853

202

(43)

297


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Financial

Statement Links -

Kodak

Statement of Cash Flows

for Year Ended Dec. 31, 1998

Operating Cash flows $ 1,483

Investing Cash flows (1,839)

Financing Cash flows 77

Exchange rate changes on cash 8

Net Change in Cash $ (271)

Cash Balance, Dec. 31, 1997 728Cash Balance, Dec. 31, 1998 $ 457

Statement of Shareholders Equity


Share Capital, Dec. 31, 1997 $ 1,892

Adjustments/Stock Issue (12)

Share Capital, Dec. 31, 1998 $ 1,880

Retained Earnings, Dec. 31, 1997 $ 5,141Add: Comprehensive Income 1,481

Less: Dividends (570)

Retained Earnings, Dec. 31, 1998 $ 6,052

Treasury Stock, Dec. 31, 1997 $ 3,872

Treasury Stock Issued 186

Treasury Stock Repurchased (258)

Treasury Stock, Dec. 31, 1998 $ 3,944

Income Statement


Sales $13,406

Expenses 12,016

Net Earnings $ 1,3 90

Other Comprehensive Income 91

Comprehensive Income $ 1,481

Balance Sheet

Dec. 31, 1997

Assets

Cash $ 728

Non-Cash Assets 1 2,417

Total Assets $13,145

Liabilities & Equity

Total liabilities $ 9,984

Equity:

Share Capital 1,892

Retained Earnings 5,141

Treasury Stock (3,872)

Total equity $ 3,161

Liabilities & Equity $13,145

Balance Sheet

Dec. 31, 1998

Assets

Cash $ 457

Non-Cash Assets 14, 276

Total Assets $14,733

Liabilities & Equity

Total liabilities $10,745

Equity:

Share Capital 1,880

Retained Earnings 6,052

Treasury Stock (3,944)

Total equity $ 3,988

Liabilities & Equity $14,733

(Period of time)

(Periodoftim

e)(Periodoftime)


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Auditing

y

Set by International AccountingStandards Board

y Not currently accepted in U.S.

y SEC under pressure to accept

IAS

y SEC requires Audit Report

y Audit opinion can be:

- clean (fairly presented)

- qualified (except for)

- disclaimer (no opinion)- adverse (not fairly presented)

y Check Auditor quality & independence

Auditors


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Notes to financial statementsj The first notes provide a summary of the firms accounting policies

j Other notes present details about particular accounts such as inventory;

property, plant and equipment; investment; long term debt.

j The notes also include

Major acquisitions or divestitures

Officer and employee retirement, pension and stock option plans

Leasing arrangement

The term, cost and maturity of debt

Pending legal proceeding

Income taxes

Contingencies and commitments

Operating segments


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Sources of financial informationMD&A

One of ways management communicates

the reasons for changes in financial and

operating data

The content of the section includes

coverage of any favorable or unfavorable

trends and significant events or

Uncertainties in the areas of liquidity,capital resources, and results of operations.


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The U.S. financial reporting system

Securities and Exchange Commission (SEC)

y Independent, quasi-judicial government agency

y Administer securities regulations & disclosures

y Can modify & set GAAP, if necessary

y Rarely directly challenges FASBy Major player in global accounting


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Financial Accounting standards board

jFASB is a nongovernmental body with

seven full-time members

j

Sets accounting standards for all companyissuing audited financial statements

j Issues statements of financial accounting

standards (SFAS) and interpretation (part of

GAAP)


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Financial Accounting Standards Board

Generally Accepted Accounting Principles

Provide input to

Help set

Securities and

Exchange

Commission

Unions

Investors

Accountants

Politicians

Lenders

Others

AICPA


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International reporting system

International Accounting Standards (IAS)

y Set by International Accounting

Standards Board

y Not currently accepted in U.S.

y SEC under pressure to accept IAS


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Demands for financial reporting

Creditors

Equity Investors

y Active & Speculative Investors rely on

financial reports

y Solvency & Liquidity analysis relieson financial reports


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Demands for financial reporting

Internal Users External Users

Managers

OfficersInternal Auditors

Sales Managers

Budget Officers

Controller

Lenders

ShareholdersGovernments

Labor Unions

External Auditors

Customers


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Accounting system feature

jAccrual accounting

jAccounting standards and auditing

GAAP reduce managers ability to distortaccounting information

Auditing improves the quality of accounting

informationjManagers reporting strategy


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Reporting strategy

Reporting strategy is policies used by management

when choosing accounting method, normally

designed to achieve specific reporting objectives

There are four common strategies

Overstating financial performance and condition

Building hidden reserves

Taking a bathOff-balance-sheet financing


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Recent Issue


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Study questions and problems

j C.Stern, chief financial officer of R-M Corp, has just reviewed the

current years third-quarter financial results. R-M Corp sets an

annual target for earnings growth of 12%. It now appears likely that

the company will fall short of that goal and achieve only a 9%

increase in earnings. This would have a potentially detrimentalimpact of the firms stock price. Stern wants to develop alternative

plans to stimulate earnings during the last quarter in order to reach

the 12% target.

j Discuss techniques that could be used increase earnings.

Differentiate between those that would

(a) Increase earnings but lower quality of reported earnings.

(b) Increase earnings and also have a positive real impact on the

firms financial position.


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j Read the auditors report for Royal Appliance Co. What type ofopinion was issued by the auditors? Explain why this type of opinionwas given.

To the shareholders and Board of Directors of Royal Appliance Co.

We have audited the Consolidated Financial Statements of RoyalAppliance Co. of this form 10-K. These financial statements are theresponsibility of the Companys management. Our responsibility is toexpress an opinion and these financial statements based on our audits.

We conducted our audits in accordance with generally acceptedstandards. Those standards require that we plan and perform the auditsto obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining

We believe that our audits provide a reasonable basis for our opinion.

Continue to next slide


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In our opinion, the financial statements referred to above present

fairly, in all material respects, the consolidated financial position of

Royal Appliance Co. as of Dec. 31,1994 and 1995, and the

consolidated results of their operations and their cash flow for each of

the three years in the period ended Dec. 31,1995, in conformity withGAAP.

As discussed in footnote 1 to the Consolidated Financial

Statements, effective September 1995, the Company changed its

method of accounting for domestic inventories from the last-in , first-

out(L

IFO) method to the first-in, first-out(FIFO) method.Coopers & Lybrand LLP

Cleveland, Ohio

March 27,1996

lecture 1 fsa

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